Financial ratios can help you compare one company's financial results to another or track the performance of a single company over time. Profitability and expense ratios measure customer demand, company pricing power and cost management efforts. Being able to calculate specific ratios from financial statements can provide an investor with insight into various investment alternatives.
Obtain current financial statements. Public companies such as General Electric and Disney publicly issue financial statements to report their financial performance and condition. These can be obtained directly from the company website, third-party financial websites such as CNBC or from the Securities and Exchange Commission.Step 2
Identify revenue and expenses. The income statement is one of the four primary financial statements companies issue. The income statement shows gross sales revenue at the top, followed by various categories of expenses that are itemized and deducted, resulting in net income, or the bottom line.Step 3
Divide total expenses by total sales revenue. The expense ratio is simply defined as the amount of costs per dollar of sales. Thus, if a company has $9 in total costs for every $10 in total sales, it has a 90 percent expense ratio. Another way to view this is that the company has $1 in profit for every $10 in sales, which translates to a 10 percent net profit margin.Step 4
Compare the expense ratio to other companies or previous reports. Once the expense ratio is calculated, it can be used to evaluate the financial health of an organization. If the expense ratio is increasing over time, the company may be losing its pricing power or not managing its costs effectively. If the expense ratio of one company is dramatically different from the expense ratios of its competitors, it may indicate that the company needs to adjust its pricing strategy or reconsider its procurement of key materials and supplies to maintain its competitiveness and profitability.
Jeff Clements has been a certified public accountant and business consultant since 2002. He has also worked in private practice as an attorney. Clements founded a multi-strategy hedge fund and has served as its research director and portfolio manager since its inception. He holds a Juris Doctor, as well as a master's degree in accounting.